THE COST OF CAPITAL FOR GOFF COMPUTER, INC. You have recently been hired by Goff
ID: 2736079 • Letter: T
Question
THE COST OF CAPITAL FOR GOFF COMPUTER, INC. You have recently been hired by Goff Computer, Inc. (GCI), in the finance area. GCI was founded eight years ago by Chris Goff and currently operates 74 stores in the Southeast. GCI is privately owned by Chris and his family and had sales of $97 million last year. GCI sells primarily to in-store customers. Customers come to the store and talk with a sales representative. The sales representative assists the customer in determining the type of computer and peripherals that are necessary for the individual customer’s comput- ing needs. After the order is taken, the customer pays for the order immediately, and the computer is assembled to fill the order. Delivery of the computer averages 15 days but is guaranteed in 30 days. GCI’s growth to date has been financed from its profits. Whenever the company had sufficient capital, it would open a new store. Relatively little formal analysis has been used in the capital budgeting process. Chris has just read about capital budgeting techniques and has come to you for help. The company has never attempted to determine its cost of capital, and Chris would like you to perform the analysis. Because the company is privately owned, it is difficult to determine the cost of equity for the company. You have determined that to estimate the cost of capital for GCI, you will use Dell as a representative company. The following steps will allow you to calculate this estimate
To estimate the cost of equity for Dell, go to finance.yahoo.com and enter the ticker symbol “DELL.” Follow the various links to find answers to the following questions: What is the most recent stock price listed for Dell? What is the market value of equity, or market capitalization? How many shares of stock does Dell have outstanding? What is the beta for Dell? Now go back to finance.yahoo.com and follow the “Bonds” link. What is the yield on 3-month Treasury bills? Using a 7 percent market risk premium, what is the cost of equity for Dell using the CAPM?
Explanation / Answer
Most recent stock price is=$10.20
Market Capitalization=17.74B
Shares Outstanding=1.74B
Dell Beta=1.59
Yield on 3-month Treasury bills= 0.01
Using a 7% market risk premium, what is the cost of equity for Dell using the CAPM?
Capital Asset Pricing Model (CAPM) Rs= RF+ X (RM– RF)
Expected return on stock (Rs) = risk-free rate (RF) + Stock beta () x Market Risk Premium (RM– RF)
= 1% + (1.59 * 7.0%) = 0.01 + (1.59 * .07) = 0.01 + 0.1113= 0.1213= 12.13
Cost of equity for Dell = 12.13%
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